Opportunities in smaller U.S. banks

By Catherine Harris | Wednesday May 31, 2017

Rising interest rates and reduced regulation may create options for U.S. banks that exploit niche markets and M&A strategies

U.S. banks will benefit if U.S. interest rates continue to rise. They will profit even more if U.S. President Donald Trump succeeds in carrying out two of his key promises: deep corporate tax cuts; and eliminating recent banking reforms designed to protect the financial system from liquidity shocks.

"On average, a cut in the corporate tax rate to 25% from 35%, as of 2018, would add 12% to bank earnings," says John Hadwen, vice president and portfolio manager at Signature Global Asset Management, a division of CI Investments Inc. in Toronto. "Some of the big global banks, like Citigroup Inc., would only see net income up by 5%-6%. But smaller, domestically oriented regional banks could see profits up by 15%. And, for some, it could be 20%."

A lighter regulatory load may reduce costs and increase lending options for some banks, helping to boost profits. However, Hadwen doesn't think there will be a lot of regulatory change, but he does expect some. He believes such changes could add 5% to earnings over three years.

On the other hand, Andrew Sleeman, portfolio manager for Franklin Mutual Series for Franklin Mutual Advisors LLC in Short Hills, N.J., doesn't anticipate meaningful regulatory change.

In this economic climate, there are at least two ways in which smaller banks can boost profits - by exploiting niche markets and by participating in mergers and acquisitions (M&As).

Here's a look at several U.S. banks that analysts say have opportunities in these two areas:

- Niche markets. First Republic Bank in San Francisco, IberiaBank Corp. in Lafayette, La., and Signature Bank in New York City are three banks that should do well even if the U.S. economy is sluggish and interest rates stay low, says Phil Taller, senior vice president for investment management with Mackenzie Financial Corp. in Toronto.

First Republic is a private bank that focuses on high net-worth clients. Taller says it has a "very high-touch service culture." That generates customer loyalty and results in a high level of referrals. The bank is expanding to other markets, including New York City, Boston, Los Angeles and Portland, Oregon. Although the stock price looks expensive, Taller argues that this bank will have higher, more sustainable growth than most of its peers.

Iberia is "a little more conventional," says Taller. It's primarily an urban retail bank in the south-east, a region that has the strongest population growth in the country, as well as lower taxes and less regulation than elsewhere. He notes that the bank's losses after the oil price plunged were "pretty minimal." He also says that Iberia's stock price is "reasonable" and the bank would be an attractive takeover target for large banks interested in expanding in the region.

Signature Bank is a business bank for small and mid-sized firms, although it often does personal banking for the owners of those companies. Customers include law, export and import firms, and real estate companies involved in multi-family apartment buildings.

Signature Bank operates solely in New York, Taller says, and has a "much more agile culture with quicker responses to customer needs" than the megabanks and grows by referral. He adds that Signature Bank has had a "stellar credit performance, including during the global credit crisis." He considers the stock price reasonable, noting that the stock traded at a big premium for several years, but now trades at a slight discount.

- M&As. Sleeman anticipates more consolidation in the U.S. banking sector: "The cost of regulation weighs on profits, particularly as banks need to invest in technology to be competitive in the medium to longer term."

New York City-based CIT Group Inc. is a finance and leasing company that filed for bankruptcy in 2009. It subsequently reorganized, paid off a significant amount of its debt and moved into traditional banking after its 2015 acquisition of Pasadena, Calif.-based OneWest Bank, which focuses on mid-sized companies. CIT also sold off its aircraft leasing business to a China-based company in 2016, which will allow CIT to buy back 40% of its outstanding shares, says Sleeman. CIT still has a railcar leasing business as well as OneWest Bank, whose worth aren't fully reflected in CIT's share price, which is around 0.95% of book value.

Weston, Fla.-based FCB Financial Holdings Inc. has US$9 billion in assets. Its subsidiary, Florida Community Bank, offers personal and commercial services in 46 branches. "[FCB] has a nice footprint and would be an attractive takeover candidate," says Sleeman.

FCB stock has been trading at two times book value.

State Bank Financial Corp., based in Atlanta, has 31 branches and eight mortgage-origination offices in Georgia. It has US$4 billion in assets and a good management team, as well as diverse capabilities, including payroll management, treasury and commercial real estate.

Sleeman says a buyer would not find a lot of costs to cut, but "it would make an interesting entry point for a bigger bank that wants to get into Georgia."